The Crash: Who Saw It Coming--And Why

by: Paul Rosenberg

Sun Sep 27, 2009 at 18:30


Back on August 29, I wrote a diary, "Who Could Have Foreseen The Housing Bubble Collapse? Dean Baker, That's Who--In 2002".  It was my intention to follow that up with some further posts on others who saw it coming.  Imagine how happy I was to discover that someone else had done it for me-Dutch economist Dirk Bezemer, writing in the Financial Times on September 7, "Why some economists could see the crisis coming".  What's more, he has a much more detailed explanation in a 51-page paper, "'No One Saw This Coming': Understanding Financial Crisis Through Accounting Models" (pdf).  Long story short, Bezemer set out to find those who had been right in predicting the financial meltdown, not just randomly, but because of a well-reasoned argument.  He found eight examples-including Baker-and analyzed what they had in common.  He discovered that they all relied on accounting models that looked at the economy in terms of stocks and flows, in sharp contrast to the standard macro-economic models that actually have no way of predicting a financial crisis, since their programming does not allow for the possibility.  That's the short argument, so that you don't have to read the rest of my diary.  If you want a better understand of what the above means, however, it would be a good idea to jump to the flip.
Paul Rosenberg :: The Crash: Who Saw It Coming--And Why
In the FT article, Bezemer writes:

From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that "no one saw this coming." .....

.... in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with "shocked disbelief" as its "whole intellectual edifice collapsed in the summer [of 2007]." Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.

It's worth noting that they also live in a world where global warming cannot destroy the world economy.  So the corrections that are needed in light of the financial crash may well not be the last word.  Rather, they should be thought of as a first draft, or a template for further rethinking that needs to be done.

I undertook a study of the models used by those who did see it coming.* They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that "the new housing bubble-together with the bond and stock bubbles-will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession"; and in 2006, when the housing market turned, that "all remaining questions pertain solely to [the] speed, depth and duration of the economy's downturn." Wynne Godley of the Levy Economics Institute wrote in 2006 that "the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010." Michael Hudson of the University of Missouri wrote in 2006 that "debt deflation will shrink the 'real' economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse." Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?

Before going on to his answer, I'd like to present the following table, reformatted from his paper, showing all the people he found who saw it coming:

AnalystCapacityForecast
Dean Baker, USco-director, Center for
Economic and Policy Research
" ...plunging housing investment will likely push the economy into
recession." (2006)
Wynne Godley, USDistinguished Scholar,
Levy Economics Institute of Bard College
"The small slowdown in the rate at which US household debt levels are
rising resulting form the house price decline, will immediately lead to
a ...sustained growth recession ... before 2010". (2006). "Unemployment
[will] start to rise significantly and does not come down again." (2007)
Fred Harrison, UKEconomic
commentator
"The next property market tipping point is due at end of 2007 or early
2008 ...The only way prices can be brought back to affordable levels is a
slump or recession" (2005).
Michael Hudson, USprofessor, University
of Missouri
"Debt deflation will shrink the "real" economy, drive down real wages, and
push our debt-ridden economy into Japan-style stagnation or worse."
(2006)
Eric Janszen, USinvestor and iTulip
commentator
"The US will enter a recession within years" (2006). "US stock markets are
likely to begin in 2008 to experience a "Debt Deflation Bear Market"
(2007)
Stephen Keen, Australiaassociate professor,
University of Western Sydney
"Long before we manage to reverse the current rise in debt, the economy
will be in a recession. On current data, we may already be in one." (2006)
Jakob Brøchner Madsen &
Jens Kjaer Sørensen,
Denmark
professor &
graduate student,
Copenhagen
University
"We are seeing large bubbles and if they bust, there is no backup. The
outlook is very bad" (2005)" The bursting of this housing bubble will have
a severe impact on the world economy and may even result in a recession"
(2006).
Kurt Richebächer, USprivate consultant and
investment newsletter writer
"The new housing bubble - together with the bond and stock bubbles - will
invariably implode in the foreseeable future, plunging the U.S. economy
into a protracted, deep recession" (2001). "A recession and bear market in
asset prices are inevitable for the U.S. economy... All remaining questions
pertain solely to speed, depth and duration of the economy's downturn."
(2006)
Nouriel Roubini, USprofessor, New York
University
"Real home prices are likely to fall at least 30% over the next 3
years"(2005). "By itself this house price slump is enough to trigger a US
recession." (2006)
Peter Schiff , USstock broker,
investment adviser
and commentator
"[t]he United States economy is like the Titanic ...I see a real financial
crisis coming for the United States." (2006). "There will be an economic
collapse" (2007).
Robert Shiller, USprofessor, Yale
University
"There is significant risk of a very bad period, with rising default and
foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected." (2006)


Continuing in his FT story, Bezemer writes:

Central to the contrarians' thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these "flow-of-funds" models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.

It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy's assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector's drain on the real economy. This allows their users to foresee when finance's relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.

This is sort of like being told that a certain kind of car has a speedometer, so that you can tell when you're breaking the law-and more importantly, when you're driving so fast you could be in danger of breaking your neck.  "Big deal," you might think.  "But don't all cars have those?  And besides, you can just see that sort of thing if you're really paying attention."  But the thing is, most economists use models that don't have speedometers.  And driving an economy is not quite like driving a car.  That's where the analogy breaks down-so badly that it needs to be junked.  So you can't so easily see how things are going.  Or as Bezemer puts it:

Such calculations are conspicuous by their absence in official forecasters' models in the US, the UK and the Organisation for Economic Co-operation and Development. In line with mainstream economic theory, balance sheet variables are assumed to adapt automatically to changes in the real economy, and can thus be safely omitted. This practice ignores the fact that in most advanced economies, financial sector turnover is many times larger than total gross domestic product; or that growth in the US and UK has been finance-driven since the turn of the millennium.

In his longer paper, Bezemer presents diagrams of what the two sorts of models look like.  First is the flow-of-funds model-taken from Hudson, who, btw, was Denis Kucinich's economic adviser in his presidential campaign:


[Click to Enlarge in New Window]

Next is a quintessential versions of the standard macro model:


[Click to Enlarge in New Window]

This is only a very cursory introduction to Bezemer's analysis.  But I've already loaded folks up with plenty of economics this weekend, so I'm going to hold off a deeper examination until next weekend.  Go look at the originals for more to chew on until then.  


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thanks for a great series this weekend (4.00 / 4)


New Jersey politics at Blue Jersey.

I confess.... (4.00 / 6)
....that I don't see any way of understanding these events that doesn't involve deliberate deception of the general public by those expecting immediate profits, as well as very extensive tacit tolerance of such deception. The official doctrine is sure to by "Shit happens, no one could have known, complexity, emergence, chaos, let's put it behind us", but I really believe that there were villains.

There are probably also forensic-accounting ways of knowing which players knew what was happening and encouraged the madness while cashing in on it, but I don't expect these methods to be used.


Oh Absolutely! (4.00 / 6)
There are multiple levels to understand this on.  ACORN was already fighting against the spread of sub-prime lending in 1999, for gosh sakes.

What I'm trying to do with the diaries I wrote this weekend is crack through some of the high-level justification/rationalization that's more or less like the modern-day equivalent of St. Thomas of Aquinas, as opposed to the specific shenanigans of one particular Pope and the church faction of cardinals that brought him to power, and all their quid-pro-quos, much less the local archdiocese and it's relationships with the local nobility.

We need to criticize the economic system on both the most basic and the most abstract levels, as well as everything in between.  Ain't no either/or lives here.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3


[ Parent ]
Not only deception, (4.00 / 6)
but threats as well, on both the micro and macro level. For the most part, they were psychological -- implied threats to the livelihood and reputation of any person or enterprise which resisted them (think what they've tried to do to universities.) It doesn't take a histrionic sensibility, I think, to imagine that the financial class would have been quite indifferent to shooting people in the streets to protect their profits. In a way, I suppose we should consider ourselves lucky that they shot themselves in the foot before there was anyone in the streets for their law enforcement agencies to shoot.

By all accounts, though, we're not done with this yet. Despite what we've supposedly learned since 2007, there's no sign that either Goldman Sachs or the Treasury Department have any intention of mending their ways. Watch this space for further developments.


[ Parent ]
Just finished reading a Zizek piece in Harper's that goes right to this. (4.00 / 1)
A noteworthy quote:
"There is a real possibility that the primary victim of the ongoing crisis will not be capitalism but the left itself, insofar as its instability to offer a viable global alternative was again made clear to everyone."

Uh, yep.


[ Parent ]
Yeah, well.... (4.00 / 1)
The theory is fine. We're working on the practice as we speak. Fine, you may say, with some justification, but what exactly have you done for us in the last 150 years?

Actually, we haven't done so badly at all, considering that little problem with ownership of the means of production. It really wasn't at all clear, in 1937 or 1938, that free-market capitalism, for lack of a better term, wasn't finished forever. Had it not been for the Cold War, in fact, it's very likely that Zizek would have little cause for concern today.


[ Parent ]
He's not reaching back farther than Clinton in that piece and so is (4.00 / 2)
speaking to very recent history and, probably, the very near future, which strikes me as fair enough. I would add that from what I know of Zizek, I feel fairly confident assuming that the dude would always find sources of concern.

[ Parent ]
A broader frame (4.00 / 3)
Yeah, I read it, and I agree. (I try not to miss anything by Zizek; like Paul, he's always provocative.) I do think, though, that the left is generally not given enough credit for its far-sightedness. Ever since Marx, it's been pretty clear that nothing like what the left recommends -- i.e. a global social democracy -- is likely to come to fruition so long as nation states, unequal economic development, and vast differences in the cultural evolution of peoples continue to exist. In other words, the communist internationals were too early, and because they attempted to organize only the industrial working classes (which were assumed to be culturally homogenous) they were always likely to be incomplete.

The truth, though, is that leftists themselves -- the deepest thinkers among them, anyway -- realized this. They were hoping, in effect, to use the industrial working classes as a model to build upon. The chances that it would work out were slim to none, but as I said earlier, the results were impressive nevertheless.

Then, of course, the forces of capital, which found crossing national borders easier because they made no pretense of engaging anything like entire populations, except as slave labor, pulled the levers of war, xenophobia, and whatever have you, to keep their enterprises coherent by reducing the coherence of the cultures they invaded. Communism -- vulnerable always to the difficulties of management in a democratic system -- was turned into a monstrous, armed, cult of the personality. (What on earth did they think that the vanguard of the working class, and the dictatorship of the proletariat was going to turn into, if not Stalinism?)

I suppose we should consider ourselves lucky that we have the social democracies of post-industrial Europe to look at today. As successful as they have proven to be, I don't think anyone on the left is blind to the fact that the destruction of European economies during the war, and the competition with Soviet communism among their own working classes after the war, had a visible hand in their success, or that what it produced in the United States, the only real victor, was the exact opposite -- an imperial state armed to the teeth against everything and everyone.

Still, the project of the left, even in the United States, once all the local jabber about universal health care and restoration of the real economy of full employment has been assigned its true value, is the same as it was when the first communist international met. This is especially true since, as Zizek points out, the goal of full employment -- hitherto the basis of any humane approach to economics -- may turn out to be a chimera in the end.

If you're not familiar with it, there was quite a bit of thinking about this 40-odd years ago, right here in the good old USA. Some of it seems astonishingly naive in retrospect, but it was still light years beyond anything coming out of Washington today. Here's a link:

The Triple Revolution

Almost no one today seems to read this sort of thing, but they should, particularly if they want to think of themselves as leftists.


[ Parent ]
thanks (0.00 / 0)
appreciate the link and recommendation.

[ Parent ]
The Zizek piece (4.00 / 1)
Here is a secondary link I found to it (only Harper's subscribers can view the whole essay online):
http://bat020.posterous.com/zi...

And here is an excerpt (rather lengthy, but check it out) I found engaging and enlightening, and not off the beam of Paul's posts encouraging us to think about economic theory.

The essay is titled To Each According to His Greed, it is from First as Tragedy, Then as Farce, a book to be published in October.

Note how Republican resistance to the bailout project was formulated in "class warfare" terms: Wall Street versus Main Street. Why should we help those on "Wall Street" responsible for the crisis while asking ordinary mortgage-holders on "Main Street" to pay the price? Is this not a clar case of what economic theory calls "moral hazard." If I am insured against fire, say, will I take fewer fire precautions (or, in extremis, even set fire to my fully insured but loss-generating premises)? The same goes for the big banks: are they not protected against big losses and able to keep their profits?

This unexpected overlapping of the left's views with those of conservative Republicans should give us pause. What the two perspectives share is their contempt for the big speculators and corporate managers who profit from risk decisions but are protected from failure by "golden parachutes." ...Does the same not hold for the Enron bankruptcy scandal of November 2001, which can be interpreted as a kind of ironic commentary on the notion of the risk society? Thousands of employees who lost their jobs and savings were certainly exposed to risk, but without having had any real choice in the matter - the risk appeared to them as blind fate. On the contrary, those who did have some insight into the risks involved, as well as the power to intervene in the situation (namely, the top managers), minimized their risks by cashing in their stocks and options before the bankruptcy. We do indeed live in a society of risky choices but one in which some do the choosing while others do the risking.

Is the bailout then really a "socialist" measure? If it is, it takes a very peculiar form: a "socialist" measure whose primary aim is to help not the poor but the rich, not those who borrow but those who lend.  In a supreme irony, "socializing" the banking system is acceptable when it serves to save capitalism. Socialism is bad-except when it serves to stabilize capitalism. (Note the symmetry with China today: in the same way, the Communist Party uses capitalism to enforce their "socialist" regime.)

But what if "moral hazard" is inscribed into the very structure of capitalism? That is to say, There is no way to separate the two: in the capitalist system, welfare on Main Street depends on a thriving Wall Street. So, while Republican populists who resist the bailout are doing the wrong thing for the right reasons, the proponents of the bailout are doing the right thing for the wrong reasons. The relationship is nontransitive: while what is good for Wall Street is not necessarily good for Main Street, Main Street cannot thrive if Wall Street is feeling sickly, and this assymmetry gives an a priori advantage to Wall Street.

Recall the standard "trickle-down" argument against egalitarian redistribution...The only kind of intervention needed is that which helps the rich get richer; the profits will then automatically diffuse among the poor. Today, this notion is alive in the belief that if we throw enough money at Wall Street it will eventually trickle down to Main Street, helping ordinary workers. So if you want people to have money to buy homes, do not give it directly to them but to those who will in turn lend them the cash. ...

Consequently, those who preach the need for a return from financial speculation to the "real economy" of producing goods to satisy real people's needs miss the very point of capitalism: self-propelling and self-augmenting financial circulation is its only dimension of the Real, in contrast to the reality of production. This ambiguity was made clear in the recent meltdown when we were simulanaeously bombarded by calls for a return to the "real economy" and by reminders that financial circulation - a sound financial system - is the lifeblood of our economies. What strange lifeblood is this which is not part of the "real economy"? Is the "real economy" in itself like a bloodless corpse? The populist slogan "Save Main Street, not Wall Street!" is thus totally misleading, a form of ideology at its purest: it overlooks the fact that what keeps Main Street going under capitalism is Wall Street. Tear that Wall down and Main Street will be flooded with panic and inflation. Guy Sorman, an exemplary ideologist of contemporary capitalism, is thus indeed correct when he claims: "There is no economic rationale for distinguishing this 'virtual capitalism' from 'real capitalism': nothing real has ever been produced without first being financed...even in a time of financial crisis, the global benefits of the new financial markets have surpassed their costs."

Whereas financial meltdowns are obvious reminders that the circulation of capital is not a self-sustaining closed loop-that it presupposes an absent reality where actual good that satisy people's needs are produced and sold-their more subtle lesson is that there can be no return to this reality, pace all the rhetoric of "let us return from the virtual space of financial speculation to real people who produce and consume." The paradox of capitalism is that you cannot throw out the dirty water of financial speculation while keeping the healthy baby of a "real" economy.

It is all too easy to dismiss this line of reasoning as a hypocritical defense of the rich. The problem is that, insofar as we remain in a capitalist order, there is a truth within it: namely, that kicking at Wall Street really will hit ordinary workers. This is why the Democrats who supported the bailout were not being inconsistent with their leftist leanings. They would have been so only if they had accepted the premise of the Republican populists: that (true, authentic) capitalism and the free-market economy are a popular, working-class affair, whereas state intervention is an upper-class elite strategy designed to exploit hardworking ordinary folks. ... The recent meltdown is itself a result of such intervention: in 2001, after the dot-com bubble (which expressed the very essence of the problem of "intellectual property") burst, it was decided to make credit more accessible in order to redirect growth into housing. ...

There is no such thing as a neutral market: in every particular situation, market configurations are regulated by political decisions. The true dilemma is thus not "Should the state intervene?" but "What kind of state intervention is necessary?" ...There is no "objective," expert position simply waiting to be applied here; one just has to take one side or the other, politically.

...When we are transfixed by something like the bailout, we should bear in mind that since it is actually a form of blackmail, we must resist the populist temptation to act out our anger and thus wound ourselves. Instead of such impotent acting-out, we should control our fury and transform it into an icy determination to think - to think things through in a really radical way, and to ask what kind of a society renders such blackmail possible.    



[ Parent ]
Dang! (0.00 / 0)
I had forgotten all about that particular document.  And never even knew it was on the web.  Thanks!

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
Deliberate deception = conspiracy (0.00 / 0)
but the meek will demure and say it was one protracted decades long "silly me!" mistake.

[ Parent ]
That's Just It (4.00 / 3)
Conspiracies are real.  But they're only part of the story.  Conspiracists think they're the whole shebang.  But the ideas I've been writing about this weekend actually matter, and they can't just be shoe-horned into a conspiracist framework.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
At this point we need massive debt foregivenesss and writedowns (4.00 / 3)
to get out of this mess.  We see Wall Street, Fed and the Administration trying to re-inflate the bubbles.  We are heading for the next lost two decades at this pace.

I agree with Professors Hudson and Keen.

RebelCapitalist - Financial Information for the Rest of Us.


the big shitpile (0.00 / 0)
A lot of short sellers saw it coming, too...

Well, The Closer It Gets (4.00 / 1)
the more obvious it is.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
Paul, Martin Armstrong of Princeton Economics predicted all this (4.00 / 1)
in his forecasting model. I first became aware of him was just before gold and silver crashed and kept on going down in the early to mid 1980's . The government was so afraid of his models, and stockbroker useage of them for profit, that they convicted him. He has been in prison for 10 fucking years now for mainstreaming the truth. He made it impossible for them to keep their scam going. And their manipulation of precious metal prices.

Here's the link:  http://tinyurl.com/yb9xhwq


Your linked article has a link damning of Sotomayor (0.00 / 0)
Viz., this one.

There were other reports about Sotomayor being a financial crook. I have't paid close attention, but I wish somebody with high visibility had, even if only to show that they were without merit.

435 Dem Primaries 2012
Coffee Party Usa
TheRealNews.Com


[ Parent ]
not to be a one trick pony (4.00 / 1)
but this diary mentions Fred Harrison and Michael Hudson...and in your last diary re: Hyman Minsky I mentioned how Georgists saw this economic crisis coming - Harrison and Hudson, two Georgists I think saw it because they (like some of the others you mentioned) see land and the speculation that is built upon the economic rent that is extracted as part of a destabilizing force on the economy.

Right, "part of a destabilizing force on the economy" (0.00 / 0)
I don't pretend to be an economic expert.  But I see no evidence for any sort of argument that a Georgist analysis is more comprehensive than what I've described in the diaries posted today.

There's a common thread that's worth pointing out--all these folks are concerned with limiting the role of speculation, and raising the role of productive real work.  George has the benefit of an inherently concrete and easy-to-grasp argument.  But it's often the case that the more abstract argument has the greatest scope and power.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3


[ Parent ]
Who should have seen it coming, but didn't, and why? (4.00 / 1)
The concept of predicting the downturn through the use of an accounting model, that is, a flow of funds model is quite rational, and is contained within the basic principles discussed in economics 101. All the economists, whose predictions of the downturn are quoted in Rosenberg's article, use higher level analyses information that to see it clearly, require the intricate mental gymnastics, if one missed the fundamentals of rudimentary economics; specifically, the relationship between liquidity, real production and the labor invested in the latter.
The stage was set around 1986 with Reagan's tax reform legislation, the real consequences of which are yet to be fully understood from a flow of funds analysis point of view.  The legislation shifted huge, (in the hundreds of billions) flow of liquidity from the real production economy over to the control of the financial community. One example is that retirement accounts to be valid, had to be managed by "qualified" financial community entities, who would ensure people didn't cheat, so individuals no longer had access or control to the extent they had before. Millions and millions of American saw their personally managed retirement accounts dwindle to 1/3 their original value, after they had been turned over to the financial community.
The immediate result was a growth of financial markets, i.e.: financial instruments therein traded, at a rate meaningfully greater than the growth of the real economy. The proportion of GDP generated in the financial market rose significantly, year after year until at the time of the bubble burst, when the financial markets and financial community represented nearly 40% (or so) of the GDP, when prior to its accelerated growth it had remained at around 5-10%.
This growth was made possible also through subsequent rounds of deregulation which made it easy for the financial community to generate liquidity at an unprecedented growth, totally disconnected from real production; and is the reason for the several intervening "smaller" crises (downturns) over the last 20 or so years.
If the liquidity had been released into the real production economy it would have meant rampant inflation; but it was obviously generally contained within the financial markets where prices continued to rise for years, when the underlying real value was not in fact consistent with the rise of prices.
Because in our "debt-based" system, liquidity can only be generated by debt, the creativity of the financial community invented all kinds of assets that could qualify for monetization. Nevertheless, the sources of new assets to monetize are obviously mathematically limited in what is nearly a closed system; hence, defaults are the unavoidable result, with huge sums of wealth transferring to lenders.
Larry Summers, director of the White House National Economic Council, had the temerity of stating that these downturns are to be expected with some regularity in our economic system, in his April 24, 2009, address to financial community at Inter-American Development Bank in Washington.  
For someone like me, not thoroughly educated in the academic terminology and methodology of formal economics, things have to make sense in a more graphical way, more closely related to my every day life, and those around me. That's when I conceived a graphical flow of liquidity and products model, which I explain this way: Imagine the economy to be an intricate navigation system, with large reservoirs, pool, lock, and gates that control the flow of liquidity, and intricate systems of canals wherein flow liquidity and vessels that depend on that liquidity to float.
Imagine such a graphic representation projected or displayed in huge wall panels or consoles, like they use for traffic control, or train control, and the information being fed real time. Then one could have seen the seismic pulses all the way back to 1986, maybe.  
So the question of who saw it coming and why should change to, "Who should have seen it coming, but didn't, and why!" Investigations are in order.
There maybe have been some too stupid to see, but overall, actions are the result of intentions. They set the stage for it to happen, saw it coming, and let it happen, and in many cases, precipitated it... starting with the Bear Stearns puts sold brought the company down overnight. No... it wasn't people buying homes they couldn't afford. These people became their scapegoats.

A National Progressive Alliance, is the only viable solution.

http://www.openleft.com/diary/...


Not Sure About 1986 (4.00 / 1)
In another diary, Mark Matson pointed to the following graph, from Kevin Drum:

The accompanying text begins:

Via Zubin Jelveh, this chart comes from Princeton economics professor Hyun Song Shin.  The data is taken from the Fed's Flow of Funds report, which shows you — unsurprisingly — how much money is flowing through various sectors of the economy.

Basically, from 1954 through 1980, the household sector grew 10x.  The corporate sector grew 10x. Commercial banks grew 10x.  And the securities sector grew 10x.  All very balanced.

The came the great deregulation. Between 1980 and 2008, the household, corporate, and commercial bank sectors once again grew by about 10x.  But securities dealers?  They exploded.  The securities sector grew by nearly 100x.



"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
1986? 1980? (4.00 / 1)
Thanks; I appreciate your memo; it add more light to what I was trying to point out, and that is the irrational growth of the financial markets in relationship to the rest of the economy, that itself having been a most important sign of what came to pass over the following 25 years.  

A National Progressive Alliance, is the only viable solution.

http://www.openleft.com/diary/...


[ Parent ]
great diary! (0.00 / 0)
Small (important!) edit needed? Shortly after the break (emphasis mine):

It's worth noting that they also live in a world where global warming cannot destroy the world economy.  So the corrections that are needed in light of the financial crash may well not be the last word.

Should that read can?

They call me Clem, Clem Guttata. Come visit wild, wonderful West Virginia Blue


Clarification (0.00 / 0)
In that passage, I'm describing their fantasy world.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
ah, my bad. (0.00 / 0)
Thanks, got it now. Adding the word "also live in a fantasy word" is a suggested edit then. But, no big deal, it's just a blog post. ;-)

This has been a great series. I think it is really important to show how we need to have a different set of thinking in order to avoid repeating the exact same problems again.

But most people don't realize yet how deep an indictment the financial crisis is for the dominant academic views of finance. It's going to take a while, but we are due for a paradigm shift.

They call me Clem, Clem Guttata. Come visit wild, wonderful West Virginia Blue


[ Parent ]
another excellent post! (4.00 / 2)
and lol, i see that paul already had a essay written about a link i posted in an earlier thread, thinking i was possibly adding to the conversation (ha!).

anyway, i'll risk it again with a comment and link or few.

first re hudson's excellent flow of funds model in the figure above, here is steve keen's comment with an important addition:

That's encapsulated in the flowchart that Bezemer copied from a paper by Michael Hudson, shown below. Without credit from the Finance sector, producer/employers don't get the finance needed to run their factories and hire workers; but with credit they accumulate debt that has to be serviced from the cash flows those businesses generate.

The component left out of the above flowchart-but incorporated in all the models praised by Bezemer for seeing the crisis coming-is that the finance system can fund not merely "good" real economy action but "bad" speculation on financial assets and real estate as well. This also leads to debt, but unlike the lending to finance production, it doesn't add to the economy's capacity to service that debt.

The growth in thus unproductive debt was the common element identified by Bezemer's "Gang of Eleven", which was why we most definitely did see "It" coming.

http://www.debtdeflation.com/b...

i highly recommend steve keen's blog, Steve Keen's Debtwatch, - in addition to the blog, he's also posted lots of useful papers, lectures and other material. steve also has an interesting history as a student having led a revolt against the teaching of orthodox economics. and his phd thesis was on minsky.

some other heterodox sites i've found interesting and helpful are:

warren mosler at his blog, The Center of the Universe:
http://www.moslereconomics.com/
see especially warren's "7 Deadly Innocent Frauds" at:
http://www.moslereconomics.com...

bill mitchell at his blog, billy blog:
http://bilbo.economicoutlook.n...

michael hudson's website (copies of his articles are posted here, frequently in an extended version of what is published elsewhere):
http://michael-hudson.com/

also randall wray, scott fullwiler, robert parenteau and others at:
http://neweconomicperspectives...

paul already mentioned the levy institute (which has a wealth of working papers to download and read), but i'll mention their annual minsky conference. the audio (mp3s) for this year's (the 18th) is available for download and i recommend the last session, #6, for presentations by galbraith, mosler, parenteau and wray.

http://www.levy.org/vdoc.aspx?...
http://www.levy.org/vdoc.aspx?...



p.s. (0.00 / 0)
re warren mosler's "7 Deadly Innocent Frauds" -- there is an amusing antidote involving al gore (thought this might tempt some to read warren's essay. it really is a fun and interesting read!)

re dean baker. i left him off my list only because i assumed everyone is already reading him.


[ Parent ]
Thanks! (0.00 / 0)
I'm sure this will help me write better follow-up diaries next weekend.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
I would add Bondadd (0.00 / 0)
who started yelling about a housing bubble in 2005 and CaclulatedRisk.

I don't really see someone predicting a bubble forming in 2001 and 2002 as all that brilliant, since housing prices are still above where they are in 01.   To really claim foresight, you need to recongize and call the peak, which some of these people didn't.  Some of the people on this list have been bearish for years - the market always has bears. That would mean they would have missed a significant bull market, and their advice wouldn't be all that usefull in the end.

Others, of course like Bondadd, have called it perfectly.

When I was a graduate student in economics studying models, one of the profs observed that there are two explanations for those who call events with perfect foresight:
1.  They are just brilliant
2.  Luck

Anyone who has been around markets for a while and around economic models in particular knows that the second is the most likely.  

Example: Nouriani has already completely missed the stock market rally (he said when the dow was at 7800 it was a dead cat bounce - he no longer says that), and is relatively more optimistic than he was six months ago.

These people deserve their due, but I would caution that their analysis was fundementally superior from the other economic models.  

Great post, though.  Exceptional.


Thanks (0.00 / 0)
I had written so much this weekend that I cut this perhaps more than I should have.  Here's a passage from the 51-page paper where he addresses the selection concerns you raise:

A major concern in collecting these data must be the 'stopped clock syndrome'. A stopped clock is correct twice a day, and the mere existence of predictions is not informative on the theoretical validity of such predictions since, in financial market parlance, 'every bear has his day'.

Elementary statistical reasoning suggests that given a large number of commentators with varying views on some topic, it will be possible to find any prediction on that topic, at any point in time. With a large number of bloggers and pundits continuously making random guesses, erroneous predictions will be made and quickly assigned to oblivion, while correct guesses will be magnified and repeated after the fact. This in itself is no indication of their validity, but only of confirmation bias.

In distinguishing the lucky shots from insightful predictions, the randomness of guesses is a feature to be exploited. Random guesses are supported by all sorts of reasoning (if at all), and will have little theory in common. Conversely, for a set of correct predictions to attain ex post credibility, it is additionally required that they are supported by a common theoretical framework. This study, then, looks to identify a set of predictions which are not only ex post correct but also rest on a common theoretical understanding. This will help identify the elements of a valid analytical approach to financial stability, and get into focus the contrast with conventional models.

In collecting these cases in an extensive search of the relevant literature, four selection criteria were applied.
Only analysts were included who provide some account on how they arrived at their conclusions. Second, the analysts included went beyond predicting a real estate crisis, also making the link to real-sector recessionary implications, including an analytical account of those links. Third, the actual prediction must have been made by the analyst and available in the public domain, rather than being asserted by others. Finally, the prediction had to have some timing attached to it. Applying these criteria led to the exclusion of a number of (often high profile) candidates - as detailed in the Appendix - so that the final selection is truly the result of critical
scrutiny.



"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3

[ Parent ]
Its important to note (0.00 / 0)
that some of the people who predicted the crash were on the right and did so because of their general hatred for the Fed.

You and I don't agree much, but I always enjoy reading you, and I probably should express appreciation for your work more.  

In general I think the overriding causes of the collapse were a lack of transparency (ie no one really understood the cross-dependencies the cds created) coupled with a serious agency problem on the part of mortgage brokers (whose compensation was not based on whether the mortgages they originated were repaid).  Any model would struggle to capture this for the simple reason that these aren't really quantifiable.

In Richard Posner's review of Keynes' masterpiece he noted Keynes did not shy from developing theories that weren't validated by numbers.  This allowed Keynes, in Posner's words, to "look into the nooks and cranies" of the economy where there were no numbers.  It was a backhanded indictment of the economics profession which spends endless time spinning linear regressions, but which as a whole fundementally missed the onset of the greatest financial crisis of the last 80 years.

I think a compelling case can be made that the torrent of data that has been unleashed in the modern age is hindering our ability to actually understand the economy because what people do not see in the numbers they do not suspect exists (to paraphrase Franklin).


[ Parent ]
Hmm (0.00 / 0)
I think we agree more than you do, then.  It's just that we tend to talk more about how we differ.  Which makes perfect sense, really.

My take on what you're saying here:

In general I think the overriding causes of the collapse were a lack of transparency (ie no one really understood the cross-dependencies the cds created) coupled with a serious agency problem on the part of mortgage brokers (whose compensation was not based on whether the mortgages they originated were repaid).  Any model would struggle to capture this for the simple reason that these aren't really quantifiable.

is that there are multiple levels of analysis, and this focuses on one of them.  While I agree that these were crucial aspects, there was a housing asset bubble forming even before the new conditions that supercharged it kicked in.  Without them, there would have been a boom and bust, but it wouldn't have been anywhere near as disastrous.  So we're basically in agreement there.  But that's not what we'd normally talk about, now would we?

I do know that some were on the right.  The use of flow and funds models is not in itself ideological.  But I don't know enough about them to know if Fed hatred played any cognitive role.  

Keynes was a very sophisticated thinker, who saw through a lot of nonsense.  Posner wasn't the first to notice this.

"You know what they say -- those of us who fail history... doomed to repeat it in summer school." -- Buffy The Vampire Slayer, Season 6, Episode 3


[ Parent ]
Transparency; cause--effect, predicting (0.00 / 0)
I believe fladem and Paul are indeed more in agreement than otherwise.

Lack of transparency is a handy overall reason accurate predictions as to time an event will take place are hard to make.

While I believe that flow of funds in combination with real production, distinguishing each, and showing nodes where these things funds tend to pool or disperse, would provide the most accurate prediction tool. However, these tools depend on accurate input, and as Paul says, when you have such instruments as CDS or securitization of any kind, it can be nearly impossible to predict an outcome. This is specially true because often each transaction is surrounded with intricate contractual obligation, provisions, and restrictions; meaning their functionality differ greatly one from another. Thus there's no visible flow to follow or predict, especially since these instruments are often secret in the first place.

Since this is a reply to the last visible post, I'll save jumping around, and add a couple of additional points:

Paul, in an earlier post you said:

We need to criticize the economic system on both the most basic and the most abstract levels, as well as everything in between.  Ain't no either/or lives here

I do agree that has to take place. But the preponderance of posts are quite abstract. I don't see enough of stuff where an abstract idea is dissected and shown how it connects to the fundamentals. This is not a criticism of anyone, because it's natural for people to write and talk at their comfort level, but I mention it because you are the lead on this topic. This approach should make the topic more appealing to broader audiences.

In another post you said:

Conspiracies are real.  But they're only part of the story.  Conspiracists think they're the whole shebang.  But the ideas I've been writing about this weekend actually matter, and they can't just be shoe-horned into a conspiracist framework.

I interpret that as "conspiratorial activity at the very top will take place, and set the stage. As we depart from the top, the lower echelons of the system react to the actions of conspirator." I mention this because most of us have been made reticent to talk about conspiracies, having been slapped with a pejorative, of "conspiracy theorist." But I think the topic should be explored, because the economy doesn't function based ONLY on macro-abstract concepts such as Minsky's or whoever, but it is micro-acted upon by those who have sufficient control to make things happen. For example, many former Goldman Sachs folks show up everywhere at the top of the economic control nodes, not only nationally, but even now, internationally, such as the Financial Stability Board, and Draghi as the director. It is difficult to suggest that these folks are very divergent in their policies, or that they never discuss cross-entity issues with each other, or that no ideas come out of those conversation. Maybe it all "just normal business chatter," and no reason to suspect any undue influence...

In another post you said:

George has the benefit of an inherently concrete and easy-to-grasp argument. But it's often the case that the more abstract argument has the greatest scope and power.

Now that 'rings' true, but I would like some explanation!

In another post you commented on mine about Reagan's 1986 tax reform, saying: "Not sure about 1986" and provided a chart showing how the financial markets began to grow at a faster rate than the real economy around 1980.

I am interested in understanding what event around 1980 contributed as a more immediate cause to the shift.

Finally, I pose this notion to anyone, and that is:

Why not run some of these discussions on wiki type software, so topics or subtopics can be better organized, easy to access? As it is, you have a good number of different top level articles, which in many ways intersect, and it becomes difficult to relate comments to different top level posting... I guess this last one is for the OpenLeft web site developers!!!



A National Progressive Alliance, is the only viable solution.

http://www.openleft.com/diary/...


[ Parent ]
1980 (0.00 / 0)
I am interested in understanding what event around 1980 contributed as a more immediate cause to the shift.

me too. see reply below (not enough room to easily reply w/ blockquote here)


[ Parent ]
1980 - reply to boldhawk (0.00 / 0)
I am interested in understanding what event around 1980 contributed as a more immediate cause to the shift.

i'm interested too. although i don't look for just one event, something high on my list of possible contributing factors is the change in usury laws (i think it was the "Monetary Control Act of 1980" http://thomas.loc.gov/cgi-bin/... ). thomas geoghegan wrote about it in harpers (april),  Infinite debt:How unlimited interest rates destroyed the economy

http://www.harpers.org/archive...

...we dismantled the most ancient of human laws, the law against usury, which had existed in some form in every civilization from the time of the Babylonian Empire to the end of Jimmy Carter's term, and which had been so taken for granted that no one ever even mentioned it to us in law school. That's when we found out what happens when an advanced industrial economy tries to function with no cap at all on interest rates.

Here's what happens: the financial sector bloats up. With no law capping interest, the evil is not only that banks prey on the poor (they have always done so) but that capital gushes out of manufacturing and into banking. When banks get 25 percent to 30 percent on credit cards, and 500 or more percent on payday loans, capital flees from honest pursuits, like auto manufacturing.

makes sense and the correlation (march 1980) is highly suggestive.

there's lots more at the link, and i recommend the geoghegan harper's article to anyone who hasn't read it. (another source on this change in usury law is william greider)

hope that's not too abstract for you... but the change has certainly had some very concrete real world effects.


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